Tag Archives: procurement tools

Unpicking The Kraljic Matrix for Procurement

In 1983, the world was introduced to The Kraljic Matrix. But is it still as relevant to procurement today?

kraljic matrix

September 1983: Peter Kraljic publishes an article that will deeply change both the working methodology and concept of many Procurement departments.

The article, published in the Harvard Business Review was titled “Purchasing must become Supply Management”. It introduced a concept that has been a key tool for procurement ever since: The Kraljic Matrix.

In this article, Kraljic advocated and argued for the need for profound transformation of the Purchasing Department into a much more strategic role. He included several examples of large organisations that had already done so, and achieved excellent results.

In order to support the required change to a more strategic role, Kraljic introduced a decision matrix. In this article, we will explain how the matrix works, and how organisations can apply it in their procurement department.

Defining The Kraljic Matrix

The Kraljic Matrix classifies the sourcing scope (also known as acquisition perimeter) from a company according to two factors.

1. Financial Impact

Measures the impact on both the manufacturing costs of the product and its impact on the profit margin.

Look at the example of manufacturing a Lego brick. Plastic would have a high financial impact, both because it accounts for most of the product cost, and because the current volatility of oil (the price of which impacts directly on plastic cost) greatly affects the profit margin.

2. Complexity of Supply

Sorts the market complexity to achieve a stable and uninterrupted supply. In this case, we must consider whether there are monopolies, logistic issues, volatility, or impact of technological changes.

An example of highly complex supply would be the chipset manufacturer for mobile phones Qualcomm. The company took over Intel and Nvidia, giving them a monopoly on the market, and the ability to refuse to supply certain organisations.

Whereas some organisations, like Samsung, chose to manufacture their own chipsets. However, not all companies can do the same.

The Kraljic Matrix

By combining both factors, we produce a chart with four perfectly differentiated groups:

  • Leverage Items

Standard commodities with an abundant source of suppliers. They are usually highly standardised, and easily available, products. Supply risk is low, though there is a high impact on costs and benefits. For example, plastic or raw material for Lego bricks.

  • Strategic Items

These are critical products for a company, and are the key focus for the Procurement team. There is high risk against supply, and a high impact on cost. For example, the Qualcomm chipsets for mobile phones.

  • Non-Critical Items

Those products that have a low impact on costs, and the supply of these is low in complexity. A good example would be, for example, standard screws in a computer factory.

  • Bottleneck Items

These are products with limited source of supply. Their supply risk is high, but do not have a major financial impact. For example, an integral part of technology hardware, the power pack for a laptop.

Analysis and Strategy

Once you have classified the products, you can define the strategies to be applied on each group in order to optimise supply. While each item will likely have it’s own specific strategy, the categorisation in The Kraljic Matrix points to a common direction and goal for each, and shows common pros and cons for each group.

kraljic-categories
Adapted from ‘Purchasing Must Become Supply Management’ – Peter Kraljic, Harvard Business Review, 1983
  • Leverage Items

We are in a so-called “buyer’s market”. Because of this, we need to negotiate to achieve the best supply conditions from a dominant position. Procurement can do this through the use of tenders, reverse auctions, setting specific target prices, or framework agreements.

  • Strategic Items

In this case, the need to mitigate risk is mutual between the supplier and the buyer. The goal here is to ensure long-term availability. Therefore, procurement needs to consider suppliers as an equal and look for a “win-win” negotiation that benefits both parties.

In these cases supplier development strategies, partnerships, and supplier innovation are recommended.

  • Non-Critical Items

There are products with low economic impact and low complexity of supply. This makes them usually the lowest priority in a sourcing strategy.

Habitually supply agreements are negotiated based on high volumes, or Kanban type solutions are implemented. A good example is the screws in the computer factory described above. These would be bought in bulk, but have a variety of suppliers available in the market.

  • Bottleneck Items

These are the opposite to Leveraged Items – we are in a “Supplier’s Market.”

In this case two parallel strategies must be followed. The first is to secure supply through framework agreements, providing for penalties for the supplier due to lack of supply while maintaining good relationships with existing suppliers.

The second, which should be done at the same time, is for procurement to work with R&D or Engineering departments to establish alternative products that can be used. This enables the organisation to reduce supply risk, turning bottleneck items back to non-critical items.

Some Advice to Heed

Although the information provided by The Kraljic Matrix may seem very generalised, it’s purpose is to help set up a basis of supply strategy.

By classifying sourcing activities using the Matrix, organisations can get a clearer picture of its available resources, priorities for negotiations, and objectives it wants to achieve.

The article wouldn’t be complete without some advice. The Kraljic Matrix is a dynamic tool – it changes, so it needs to be reviewed frequently. Markets have become more dynamic, and the supply situation can change significantly in short time periods.

Being able to adapt to these changes is a critical success factor for Procurement. Therefore the tools used to develop strategies must also be dynamic and flexible, which is why the Kraljic Matrix can provide great value for organisations.

5 Price Analysis Methodologies to Apply to Negotiated Costs

How can you find out if you’ve got a good deal from your negotiation? Here are some price analysis tools that could help you out.

Volume Price Analysis

One of the key performance measures that invariably arises at the end of a negotiation is if the final price achieved is a good one or not.

If we, as buyers, have purchased the product or service for a number of years, we can rely on our experience. But we have all faced a situation when we have to deal with an unfamiliar product. What do we do then?

I have outlined the pros and cons of some different approaches to price analysis. There’s no magic formula we can apply to confirm if the negotiated cost is accurate to the market price.

Each price analysis method has its own strengths and weaknesses. Knowing them will help us to understand which one to apply in which situation.

Price Comparison

The most basic method. You take the final price, and compare it against the prices quoted for the same product by other suppliers in the market place. This is the most common method, and it’s usually applied to common products, or those with transparent pricing.

Pros:

  • Doesn’t require too many resources.
  • Relatively easy to find out if the cost is over the market average.

Cons:

  • It can only be applied to common products – it should not be used, for example, for the cost of a lab analysis service, or customised goods.
  • You have to work with updated costs – in some areas, like electronics, a 6 month old cost may be obsolete.
  • You have to compare exactly the same product, under the same circumstances – not, for example, two different mobile phones, or services from two different countries.
Cost Structure

If it’s not possible to find equivalent market prices for the products or services, procurement can use the approach of a detailed cost structure analysis.

In order to do it, we ‘only’ have to replicate the manufacturing process, and assign an estimated cost to each stage. We can then benchmark this result against the cost provided by the supplier.

With a service, rather than a product, the process requires disaggregation of the service into its constituent parts (salaries; materials; equipment), and a cost assigned to each.

Pros:

  • Provides a detailed view of costs.
  • Can be used as a basis for supplier partnerships, and to visit supplier facilities to look at the manufacturing process.
  • Allows for negotiation on each constituent part of the good or service, increasing potential for savings.

Cons:

  • In-depth knowledge of the manufacturing processes and costs is needed.
  • Resource heavy.
  • Without supplier input, manufacturing process costs will be estimated, increasing the error margin exponentially.
Price Index

If the product has a published price index, then it is logical that the index will be a good guide to check if the negotiated cost is a good one. It would then be a matter of comparing the negotiated and index price to see if the negotiated cost was good or not.

The process is a bit more complex than that, but for the purposes of this article, there is no need for further explanation.

Pros:

  • Price indices usually are available on the Internet under paid subscription. As an added value, these sites usually offer forecast analysis that could be helpful for ongoing procurement strategy.
  • Can show trends and provide a comparison to the cost the last time the product was purchased. For example, if a product index has decreased a 5 per cent, but the supplier has only offered a 2 per cent cost decrease, then it’s clear that there is room for further negotiation.

Cons:

  • The indices are just a guide, there is a more complex cost structure which has to be considered. For example, other factors, such as a trader’s fee, would not be expressed as part of the product cost.
  • Indices only have a partial influence on the final price. A drop of 30 per cent on a factor, such as petrol price in the plastics market, wouldn’t necessarily mean a 30 per cent drop in the product price.
  • Markets can fall victim to speculation, or an issue that distorts the index. Being unaware of these issues prior to a negotiation could lead to a higher than expected cost.
Unit Price Analysis (UPA)

The Unit Price Analysis (UPA) is a mathematical model which predicts the right cost that a product or service should have based on its specific properties or details. It’s like a price calculator.

Pros:

  • We have access to a goal cost before starting negotiations.
  • Companies have developed their own UPAs based on non-linear regression statistical analysis. You can hire their services in the same way as you sign up for Price Index sites.
  • They are quite helpful when calculating complex project costs, and provide an accurate cost result for EPC projects.

Cons:

  • Building this model from scratch is expensive. Nearly all companies outsource this service.
  • You must be sure that data comes from a trustworthy source before using it for a negotiation.
  • UPAs are unitary prices based on a specific volume. The data doesn’t support different volumes.
Conclusion

In addition to the price analysis tools outlined above, there are a number of other, less common, ones. They are less used as they can only usually be applied to very specific cases.

There is no, one correct method. The specific circumstances of each sourcing activity will determine which method can be best applied to the post-negotiation benchmarking activity.